All tied up and nowhere to go?
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THERE WERE 113 bankruptcies and 164 liquidations in the industry during the period January to June, according to the latest figures released by the Department of Trade.
The recession's to blame, of course, but when the official reeiver's called in he often finds -nany companies haven't taken :he effects of inflation seriously anough and haven't realised its 'ull implications.
The smaller operator is Jsually the first to suffer, though :nany companies won't feel the 'Lill impact of inflation until eco-iomic recovery is well under Ivay and they need to replace tehicles and trailers at current )rices.
Financing is an area where the :ffects of inflation show up nost: An operator running 50 fehicles in 1970 with a four-year eplacement cycle needed an an lual capital investment of 20,000. By 1974 the cost had isen to E34,000, spiralling to )ver £72,000 in 1977, and eached nearly £100,000 in 1980. .o maintain a similar investment irofile, the replacement cycle vould have to drop from 13 ehicles to under four.
But the rise in the purchase rice isn't due to inflation alone improved specifications to omply with an ever-increasing mount of legislation is also resonsible.
If operators realise that iere are two main ways in thich inflation can effect their usiness they are well on the /ay to grasping its implications. First, it affects his total operaonal costs and vehicle acquison programmes, with vehicles apresenting an even larger utlay than they did.
The total operational cost can e absorbed through changes in le company's external rates if s a public haulier or through iternal charges if transport is )rin-house use.
Second, the changes in cost antres can mean that the whole )st mix has to be reconsidered. -om an operational viewpoint is is very important, as it bear-nes very difficult to predict ture costs of replacement cy
cies and evaluate financing options.
The key operating cost centres will need individual adjustment before being included in the overall cost mix and longer term costs for extended contract rate.
Inflation not only increases new vehicle prices and the operating costs of the older ones but also erodes working capital so any method of supporting the company working capital even in the short-term must be welcome.
No two transport companies have exactly the same requirements for their fleet financing programme in times of rising costs, but the basic factors are similar and these can be identified when evaluating alternative methods of vehicle financing.
It will help you decide if your bear these points in mind: Will the method of payment decided upon to allow the company to spread its repayments over a period or must the vehicle be paid for immediately? The longer the financing period, the lower will be the real cost because the company will be paying for an asset at today's prices but paying out of tomorrow's inflated money.
Is the initial payment large enough? The operator many have the chance to reduce his monthly payments by paying a larger deposit — but is this to his advantage now or could these future funds, which would otherwise be tied up, be better used elsewhere in the organisation?
Will funds actually be released? By selecting a particular method of acquiring new vehicles or alternatively arranging the sale and lease back of existing ones, it may be possible to free funds from transport and use these for other company activities.
Can the company put released funds to any better use? If the company cannot use released funds to improve profits or cut costs, it may not be worthwhile considering another method of vehicle acquistion.
If the vehicle has been leased and the arrangement ends, will the operator benefit in any way when the leasing company sells the vehicle — leasing has tended to prohibit this.
The fleet operator who is able to adjust his vehicle operational life to take advantage of shortterm market changes can reduce his costs compared with a company whose vehicles are on a ridig cycle.
Does the financial arrangement make the best use of any tax relief? The astute accountant should be able to find "net rate leasing" where the tax allowances on the capital have already been claimed by the lessor. This enables the rate to be cut.
If the fleet is to be financed during a period of high interest rates, a method of finance should be chosen which allows interest rates to be adjusted.
The three most common methods of interest rate calculation for leasing money are: Fixed rate interest The lessor takes the risk for the rate increasing but also benefits if it goes down (assuming he is financing for a short term basis only). The main advantage to the fleet operator is that his funds are at a fixed rate, so for budgeting purposes he has a known sum every month.
Semi-fixed rate The two parties agree a rate of interest as a margin over base rate and the true rate, converted into a fixed rate equivalent. The monthly or quarterly rental is calculated with reference to this fixed rate equivalent and that is held throughout the contract period.
Any fluctuations in the base rate are accounted for on an annual basis of a surcharge or refund. When the base rate increases, an additional payment would be needed or a decline in the base rate would allow a refund.
Floating rate This is a popular alternative with bankers because the lessee pays a rate which is varied on a monthly or quarterly basis in accordance with any changes in the reference rate. This is usually the finance house base rate. So the operator will benefit from any decline in the cost of finance.
Which interest method?
When interest rates are high, the operator should take advantage of any possible drops which could happen during the life of the asset or period of contract. Therefore the type of interest rate that he needs is floating.
To explain this, during late 1976 and early 1977 when the minimum lending rate peaked at 15 per cent, the lease interest rate was astronomical. The ac
countant who committed his company to fixed-rate finance at that time should now be on his travels because ten months later the base rate had fallen to a little over five per cent!
Conversely when leasing or other sources of finance are cheap, the operator may be well advised to seek a fixed rate in order to hedge against shortterm fluctuations and thus be able to budget more accurately.
It could be well worthwhile for the operator to pay slightly over the short-term odds to get the rate which represents the longer-term economic forecast most accurately.
During the last few years there has been a big growth in the number of variations on vehicle finance schemes available in the UK.
Though few of these methods are new, a range of variations make certain schemes more suitable for certain circumstances. Some are aimed specifi cally at inflation, others to reduce cash flows, and others to gain benefit from tax relief.
Vehicle acquisition The basic methods of vehicle acquisition can be divided into two groups — purchase, whether outright or deferred or financial on borrowed money; and various forms of hire with fixed or varying terms, with or without maintenance. It may also be possible for the lessee to gain in any residual selling value through the application clauses.
The four most popular methods of commercial-vehicle acquistion are: outright purchase, hire purchase, finance and open-end lease.
In all cases, an accountant is able to make his tax claims immediately and the flexibility of payment is not regulated by any control of hiring orders, but more by commercial considerations.
The full 100 per cent of written down value is allowable against corporation tax in year one; 100 per cent of rentals are also allowable for commercial vehicles.
If the entire 100 per cent is not claimed in year one for commercials, carry-over rules allow only 25 per cent per annum to be written down.
Outright purchase
For simplicity, consider a vehicle costing £10,000 which is to be used for seven years. This has an assumed residual value of £2,540 at the end of four years in a steady state economy and £4,500 in the inflating economy. The 100 per cent tax allow
ances are claimed in the fir year and 50 per cent of ti allowance is deducted as the r lief of allowance against tax. TI net present cost at ten per ce for the steady state econon and 20 per cent for the inflati nary case is £4,843 and £5,1 respectively.
Hire Purchase Acquiring vehicles under hig purchase facilities gives tl operator the advantages of u; hire and purchase durir periods of both inflation al economic stability. The cost tax-allowable in the first ye. while payments are spread ov an extended period, allowing t company to take part in the re dual value of the unit.
Again, assume that the vehii costs £10,000 and it is to be quired over a four-year peric Also that the company is able claim all available tax alto ances. The cost of acquiring t vehicle under steady econon rate would be £5,588 and £4,E under inflationary conditions Fixed-term lease
This method has the adv. tage of a fixed period of time a monthly rental. No furtlpayments have to be made. 1 £10,000 vehicle would have a present cost of £5,078 in steady state economy a £4,536 under inflation cor tions.
Open-end lease
The operator can benefit b from deferred payments, n dual value participation, C through the leasing corm:1i' claim the capital allowances the first year and so be abl€ charge a rate net of tax all( ances — the net rate lease.
This approach is also availa with fixed-term finance leasi Using this method, the E10,1 vehicle would have a net pres cost of £4,924 in a steady si economy and £4,057 in infla nary conditions.
Summary When considering vehicle newal and acquisition, the m important aspect the account must consider is the compar cashflow.
Currently, the alternatives hire, with a floating interest rather than outright purch. are the most economical in long term if you can afford tI initially (£4,057 compared 1, £5,112 for outright purchasi Now, outright purchase is worst cashflow position of a not only is company money up but it also takes a long tim be recovered.